Impact of Trade Liberalization on Environmental Quality: A Panel Study of Selected Asian Countries

Abstract

The ongoing climatic changes and the global warming have intrigued researchers to explore the impact of different policies on the environmental quality. In this study, we focus on the question as to whether freer trade policy is compatible with environmental quality standards. There is no simple pattern of the association between the trade and environmental quality. The main objectives are to construct an index of Trade Liberalization Policy, to investigate the role of the trade liberalization in the environmental quality by decomposing the scale, composition and technique effect and to explore the additional social and institutional channels through which trade liberalization may cause environmental quality. The estimated empirical findings regarding the effects of the trade liberalization policy on imports and exports are strong and robust in different model specifications. Reductions in export and import duties have a significant positive effect on imports and exports of the panel countries with the overall impact on imports being greater than exports, while the liberalized trade regime has a significant positive influence on expanding trade volumes. The empirical findings reveal a mixed but moderate effect of the trade liberalization policy on the environmental quality. Trade liberalization policy appears to affect environmental quality differently through different channels. The net affect also varies across different pollutants. The trade liberalization policy has a detrimental effect on the environmental quality, through six out of ten channels. The channels which appear damaging to the environment include scale effect, energy use, manufacturing, democracy, poverty and xvii foreign direct investment. However, the trade policy liberalization benefits environment through four channels which include technique/income effect, physical capital, human capital and control over corruption. The net impact of liberalized trade policies is detrimental to the environment in case of carbon dioxide and composite index of emissions. However, in case of sulfur dioxide emissions, the overall net impact appears beneficial to the environment by lowering the SO2 emissions. This study has also examined the performance of the model by applying standard forecasting techniques such as within-sample and out-of-sample forecasts. The findings demonstrate that the model tracks data well and has very small mean prediction errors. The Theil’s Inequality Coefficient (TIC) also approaches zero in almost all cases. Thus the model can be used as a tool for carrying out structural analysis, forecasting and policy evaluation. Overall, in the trade-environment nexus, this study justifies the ambiguity regarding the impact of the freer trade on the environmental quality through different channels offering opposing effects. The findings of the present study necessitate the policy formulation to be multi-dimensional for dealing with simultaneously occurring positive and negative impacts.